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Three recent decisions of the U.S. Courts of Appeals have given teeth to the provisions in the Private Securities Litigation Reform Act of 1995 (“PSLRA”) that attempt to make securities class actions less “lawyer driven” by placing control in the hands of a sophisticated plaintiff with a real financial incentive. Opinions issued by the 3rd, 5th and 8th U.S. Circuit Courts of Appeals have given force to that objective in cases involving class certification, control of the litigation and selection of lead counsel. On class certification, in Berger v. Compaq Computer Corp., 257 F.3d 475 (5th Cir. 2001), the 5th Circuit considered whether the lead plaintiffs appointed as class representatives were qualified to represent a class of Compaq shareholders. Pointing to deposition testimony which showed the class representatives’ “indifference to and ignorance of key facts” in the case, Compaq argued that the plaintiffs had failed to show that the designated class representatives were controlling the litigation. The court held that the district court erred in certifying the class in two respects. First, it improperly shifted the burden of proof to the defendants by adopting a presumption that the class representatives were adequate in the absence of specific proof to the contrary. The court held that it is the burden of the party seeking certification to prove that the class representatives will fairly and adequately protect the class. Second, the court held that the PSLRA raised the “adequacy” threshold for class representatives in securities class actions. It found that in actions governed by the PSLRA, “adequacy” must reflect “Congress’ emphatic command that competent plaintiffs, rather than lawyers, direct such cases.” Satisfying that standard, the court held, requires that the class representatives possess a sufficient level of knowledge and understanding to be capable of “controlling” or “prosecuting” the litigation. The 8th Circuit, in In re BankAmerica Corp. Securities Litig., Civ. No. 00-2255, 2001 WL 965141 (8th Cir. Aug. 24, 2001), considered whether a district court presiding over a federal securities class action violated the Anti-Injunction Act by granting an injunction that effectively halted a parallel California state-court class action. In a two-to-one decision, the court held that the injunction was proper to preclude the state court plaintiffs from assertedly seizing control of the litigation of the federal claims. It ruled that the PSLRA creates significant federal rights on the part of a lead plaintiff to exercise control over discovery, choice of counsel, assertion of litigation theories, and settlement negotiations. Allowing the state court action to proceed, the court held, would have subverted the PSLRA by rendering these rights meaningless and “putting small stakeholders in the driver’s seat.” Most recently, the 3rd Circuit, ruling on the settlement of the securities class action against Cendant Corp., threw out a $262 million award of attorneys’ fees, on grounds that the lower court’s decision to auction off the right to be lead plaintiffs’ counsel violated the PSLRA. In re Cendant Corp. Litig., Civ. No. 00-2520, 2001 WL 980469 (3rd Cir. Aug. 28, 2001). The panel upheld the record $3.2 billion settlement, but ordered the district court to recalculate the attorneys’ fees. The lead plaintiffs, three large institutional investors, sought to appoint as lead counsel two firms with which they had negotiated a retainer agreement. The district court declined to approve their choice, instead ordering an auction, but giving the two firms the option of matching the lowest bidder, which they did. The 3rd Circuit held that the lead plaintiff should be given discretion to retain counsel of its choice. It concluded that the lower court’s “decision to hold an auction to select lead counsel was inconsistent with the Reform Act, which is designed to infuse lead plaintiffs with the responsibility (and motivation) to drive a hard bargain with prospective lead counsel and to give deference to their stewardship.” Because the district court’s process resulted in the firms selected by the lead plaintiff being chosen anyway, the court ruled that the error was harmless. It held the fee award improper, however, because the lead plaintiffs’ initial retainer agreement required prior approval of the fee application, which counsel had not obtained. Each of the decisions broadly interprets the rights afforded to lead plaintiffs by the PSLRA. They signal a distinct effort to encourage institutional investors — who assertedly have the necessary financial interest, resources and experience — to assume a leadership role in securities litigation. Whether this will further the fundamental purpose of the PSLRA — to deter abusive securities class actions — depends on whether the courts will be equally vigilant in enforcing the pleading, discovery, damages, safe harbor and other provisions of the PSLRA designed to protect defendants.

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